To revive economic growth, Nirmala Sitharaman should sidestep this trap

The rate of growth of industrial output in India has slowed down hugely. Along with it, so has overall GDP growth.

A look at the Indian experience since 1951 reveals a broad pattern in which a short growth phase of about five years is followed by a longer slump of about six years.

Between 1952 and 1964 growth was driven by public investment. Then the money ran out and, from 1965 to 1970, there was stagnation in both investment and consumption. It was called a ‘plan holiday’ to denote a virtual full stop to state-led investment. 

From 1972 to 1978 growth was driven in equal measure by investment and consumption. Both were financed by huge increases in public spending. But the fiscal balance was maintained. That revival ran its course by 1979 when a massive drought and the second oil shock stopped growth dead in its tracks. 

Between 1981 and 1984 India was under IMF discipline and growth didn’t happen because state investment was kept low to keep the fiscal deficit low and, thanks to socialism, private investment was not encouraged. So both investment and consumption suffered. 

Between 1985 and 1990 growth was revived by a massive push for private investment, and a lesser but not insubstantial push for consumption. But the huge increase in aggregate demand that this occasioned led to a balance of payments crisis in 1991 because India could not produce enough domestically and had to take recourse to large scale imports. 

Nirmala Sitharaman

That led to another clampdown on consumption but private investment was given a huge fillip because of another IMF discipline. This time industrial licensing was abolished and import tariffs lowered. The financial sector was also liberated.

So the growth phase of 1993-98 was driven by investment once again. But, soon enough in the absence of enough growth in incomes and therefore consumption, this phase also came to a halt when overcapacity emerged. That growth slowdown lasted till 2003. 

After 2004 India returned to another investment and consumption led growth phase. Consumption was driven by huge fiscal deficits for funding rural incomes, as also by private investment funded by unprecedented high corporate borrowings. By 2011 both had collapsed to the accompaniment of high inflation. This had happened once before during 1989-91. So in 2013 there was very nearly another balance of payments crisis, which was averted narrowly.

Between 2014 and 2017 growth was once again driven by consumption when the ill-conceived demonetisation of November 2016 killed it. In July 2017 the poorly thought through and badly implemented GST choked off residual investment as well. Thus, what the government is grappling with today is part of a long term pattern that sees around four years of robust growth in both investment and consumption which is then followed by around five years when both collapse. 

Tempting as it is to call this a business cycle the fact is that it is a result of large fiscal expansions followed by savage fiscal contractions. India’s governments keep overshooting in both directions all the time. This is the trap Nirmala Sitharaman has to avoid when she presents her budget two months from now. 

The pressure will be to boost consumption but that, in my view, would be the wrong policy choice. The key lies in boosting investment. So it’s the Finance Bill we must look to rather than the expenditure budget.
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